Global stock markets will slump further into turmoil if there is a war on Iraq without a clear United Nations mandate, the City is warning.

Bond and stock traders fear action by the United States and Britain without backing this week from the UN Security Council could lead to economic and financial disruption around the world.

'The political damage could be massive - globally, regionally, between and within nations - new world disorder,' said Mark Cliffe, chief economist at ING Financial markets. 'This would imply greater postwar instability, heightened terrorist risks and collateral damage to economic relations.'

Cliffe believed this 'would see US growth dive back to zero, stock markets take another dive, the Fed cutting its funds rate to 0.5 per cent and the dollar down to €1.20'.

Japanese markets are already at a 20-year low, European markets are touching seven-year lows, and the FTSE 100 index fell every day last week, ending up below the 3,500 level that sees the prospect of forced selling under insurance company solvency rules.

In recent weeks movements of the dollar on foreign exchanges have become acutely sensitive to news that harms the American case for war at the UN, such as Iraq's destruction of proscribed missiles, and the dovish tone of reports from weapons inspectors, according to research by Morgan Stanley.

David Buik of Cantor Index said: 'Bush is giving people the opportunity to join him but he's not that bothered what their response is. That's pretty worrying because it could leave the world in serious disarray.'

Many economists pointed to the direct financial costs of the US and Britain acting without the UN. 'What the market's taken so badly is the feeling that the US is going it alone and the costs of war are very high,' said Hilary Cook, director of investment strategy at Barclays Private Clients. The bills would be easier to accept if they were pooled.

A study by Lehman Brothers' chief economist John Llewellyn says that regardless of who backs any action there is a one in 10 chance of an 'open-ended conflagration' which would lead to a Viet nam war-sized bill for the US, 'equivalent to 12 per cent of contemporary GDP', or $1.2 trillion.

Avinash Persaud, managing director of State Street Bank, believes timing is vital: 'The market wants whatever happens to be quickly resolved, and unilateral action is less likely to be quickly resolved.

'A UN-sponsored resolution that led to the UN-sanctioned rebuilding [of Iraq] is most conducive to swift action.' Economists warn that even a quick, successful war for the US is unlikely to lead to a surge in markets or immediate economic upturn.

Persaud added:'Investors will be waiting on the sidelines for peace, rather than buy on the sound of gunfire.'

· Just days before a possible war, US firms are buying two- thirds of the Iraqi oil exported under the UN oil-for-food programme, said the research firm Energy Intelligence.